Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $80 per unit. Variable expenses are $40.00 per unit, and fixed expenses total $160,000 per year. Its operating results for last year were as follows:

Sales	$	2,080,000
Variable expenses		1,040,000
Contribution margin		1,040,000
Fixed expenses		160,000
Net operating income	$	880,000

5. The sales manager is convinced that a 14% reduction in the selling price, combined with a $64,000 increase in advertising, would increase this year's unit sales by 25%.

a. If the sales manager is right, what would be this year's net operating income if his ideas are implemented?

b. Do you recommend implementing the sales manager's suggestions?

6. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $2.40 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's sales by 25%. How much could the president increase this year's advertising expense and still earn the same $880,000 net operating income as last year?

Answer 1

Given data:

Total sales value = $ 2,080,000

Selling price per unit = $ 80

No of units sales = 2,080,000/80 =26,000 units

Variable expenses per unit = $ 40

Total variable exp = 26,000*40 = $ 1,040,000

Total fixed cost = $ 160,000

Net operating income = $ 880,000

5. If Selling price reduced by 25% per unit, combined with $ 64,000 increase in advertising exp, would increase unit sales by 25%:

a) Calculating net operating income:

New selling price per unit = ($80- 80*25/100) =$ 60

New total selling unit = (26,000+26,000*25/100) =32,500 units

Total sales =32,500*60 = $ 1,950,000

Variable cost per unit = $ 40

Total variable cost =32,500*40 = $ 1,300,000

New fixed cost = $ 160,000+ 64,000 = $234,000

Contribution = sales – variable cost =1,950,000-1,300,000 =$ 650,000

Contribution ratio = contribution/ sales*100

So, contribution ratio = 650,000/1,950,000*100 =33.33%

Sales= fixed cost+net operating income /contribution ratio

1,950,000 = 234,000+ net operating income /33.33%

1,950,000*33.33/100 =234,000+net operating income

650,000-234,000 = net operating income

Net operating income = $ 416,000

Proof:

Sales =                         $ 1,950,000

Variable exp =              $ 1,300,000

Contribution margin = $    650,000

Fixed exp = $     234,000

Net operating income= $   416,000

b) sales manager suggestion is not recommendable to implement, because the new total net operating income is lesser than old. I,e., new operating income = $ 416,000, but old net operating income $880,000.

6) Increase sales commission per unit $ 2.40, combined with some increase in advertising exp, would increase sales by 25%, how much increase the advertising exp to earn a $ 880,000 as net operating income:

Selling price per unit = $ 80

New total selling unit =26,000+26,000*25/100 = 32,500 units

Total sales = 32,500*80 = $ 2,600,000

Variable exp = $ 40+ 2.40 = $ 42.40

Total variable exp = 32,500*42.40 = $ 1,378,000

Contribution = Sales-variable exp =2,600,000-1,378,000 =$ 1,222,000

Contribution ratio = contribution / sales*100 = 1,222,000/2,600,000*100 = 47%

Sales =total new fixed cost+ net operating income/contribution ratio

Total new fixed cost+net operating income =sales*contribution ratio

Total new fixed cost + 880,000 = 2,600,000*47/100

Total new fixed cost + 880,000 = 1,222,000

Total new fixed cost = 1,222,000-,880,000 =342,000

Therefore advertising exp =total new fixed cost – old fixed cost

342,000- 160,000 = $ 182,000

Answer 2

Req 5-a	Contribution Income   statement
		Last Year		Proposed
		26,000	Units	32,500	Units
		Total	Per Unit	Total	Per Unit
	Sales	2,080,000	80.00	2,236,000	68.80
	Less: Variable expense	1,040,000	40.00	1,300,000	40.00
	Contribution margin	1,040,000	40.00	936,000	28.80
	Fixed expenses	160,000		224,000
	Net Income	880,000		712,000
Req 5-b	Net Operating Income Decrease by	(168,000)
Req 6	The amount by which advertising can be increased	182,000
	Working Note :
	Contribution margin per unit (Last year)	40.00
	Less: increase in sales comm	(2.40)
	Prposed contribution margin	37.60
	Multiplied by proposed sales after increase	32,500
	Proposed total contribution margin	1,222,000
	Less: Fixed expenses	(160,000)
	Less: Target Income	(880,000)
	The amount by which advertising can be increased	182,000